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Predicting a bubble is a fool's errand, but as a writer for The Motley Fool I might as well put my Fool hat on and take a shot.
If I remember my economics correctly, the laws of supply and demand eventually balance themselves out in the real world. Prices go up when demand outstrips supply, and prices go down when supply meets back up with demand. That's exactly how I am going to predict the day (plus or minus a few months) the rare earth bubble will pop.
Let me be very clear, I don't think Molycorp (NYSE: MCP ) Rare Element Resources (AMEX: REE ) or China Shen Zhou Mining & Resources (AMEX: SHZ ) will be falling off a cliff any time soon. For now, rare earth elements are in a state of very high demand and supply is tight with China's export restrictions. Combine that with the inelasticity (meaning buyers will pay whatever price it takes) of rare elements, and prices have gone through the roof in recent months.
The problem for rare earths going forward is a glut of supply coming into the market. These rare earth elements aren't really rare, so anyone with a possible mine is building mining capacity or at least drilling to see what they've got. One of those mines can make a big dent in world supply, and the world has a half-dozen or more in the works.
As it stands right now, there is demand for 130,000 metric tons of rare elements annually, and China, with lower export quotas, is exporting 30,000 metric tons a year. Molycorp estimates there are 50,000 metric tons of demand outside of China right now, so supply is 20,000 metric tons below demand, causing high prices. But supply will be increasing as capacity comes online in the next few years.
Capacity (metric tons)
|Molycorp||~Q3 2012||20,000 (up to 40,000)|
|Avalon Rare Metals (AMEX: AVL )||2015||10,000|
Assuming China doesn't cut off exports altogether (a possibility at this point) and exports stay around 30,000 metric tons annually, Lynas will be able to pick up all of the slack in 2011. If supply and demand are aligned around 50,000 metric tons annually by the start of 2012, where will that leave us? Molycorp, which will likely increase capacity to 40,000 metric tons (if my crystal ball reads correctly), comes online in 2012 and the two companies can supply the world's needs (outside of China). Even if you think demand will go to 70,000 metric tons by 2012, there should be plenty of supply.
Then comes Arafura, Avalon, Rare Element Resources, Quest Rare Minerals, the list goes on and on. Even if we reach 210,000 metric tons of demand by 2015, the new mines should be able to pick up the slack, leaving supply and demand more in line.
I also haven't considered rare earths being designed out of some products, a half-dozen other mines in the works, new recycling technology, or the possibility the World Trade Organization rules China can't restrict supply to the rest of the world.
A big word of caution
The first big drop could come on Jan. 25 when Molycorp insiders can start selling their own stock. Last year, Tesla Motors and A123 Systems both saw price drops on the day their lockup period ended. Molycorp will likely see the same.
Predicting the fall
Molycorp will take its first nosedive on Jan. 25, but the big fall will start later in the year when people realize there won't be a shortage for long. If you're looking for an exact date, I'll throw a dart at the calendar and get ... Oct. 12, 2011.
What to do now
If you have the gumption to stay in the rare earth trade until the bitter end, you have more guts than I do. For a lightweight way to play rare earths, there is the Market Vectors Rare Earth/Strategic Metals ETF (NYSE: REMX ) . The ETF invests in other metals benefiting from high-tech manufacturing like Motley Fool Stock Advisor pick Titanium Metals (NYSE: TIE ) and Thompson Creek Metals (NYSE: TC ) . Neither are really rare earth plays, but they both have solid revenues, unlike rare earths, and will benefit from the same high-tech movement driving rare earth prices higher.
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